Saturday, November 15, 2008

The Corporate Tax Hike of 1932 on Small Business

From 1918 until 1931, the U.S. had a flat tax on corporate income, with a tax rate of 0% for the first $2,000 of income from 1918 to 1927 (equivalent to $26,000 today), and a tax rate of 0% on the first $3,000 of income from 1928 to 1931 (equivalent to $43,000 today), see IRS data here. Starting in 1932, the lowest rate was increased to 13.75% on all income (see chart above). A small company making $43,000 (in today's dollars) in profits would have paid no corporate income tax in 1931, but would have paid almost $6,000 in 1932 (today's dollars). A small company making $100,000 in profits (today's dollars) in 1931 would have paid less than $7,000 in tax (today's dollars), but almost $14,000 in taxes in 1932, a two-fold increase in one year, as the top rate increased from 12% to 13.75%, and the 0% rate was eliminated.

For an economy struggling with a stock market crash, thousands of bank failures, and rising unemployment, it would seem like the last thing considered would have been such a huge tax hike on all businesses, but especially small businesses.

By 1941, the bottom rate on the first $5,000 of corporate income was 21% and the highest rate was 44%, and the initial pro-business flat tax became an anti-business progressive tax system.

The data does not support the theory that if you tax something you get less of it.

There are several problems with your argument.

First, you are equivocating on the meaning of the terms “something” and “it” in that theory. You are using “something” to refer to corporate profits while using “it” to refer to taxes collected on those profits. So in your usage, “something” and “it” are two different things -- whereas in the theory they are the same thing.

Thus the theory does not say that if you tax corporate profits, you will collect less in taxes; it says that if you tax corporate profits, you will tend to get less corporate profits than you otherwise would. So your data doesn’t speak to the theory one way or the other.

Second, ceteris paribus definitely applies here.

The period from 1940 - 1945 was marked by huge increases in government spending for defense items. Here is defense spending in billions for the war years:

By 1943, defense spending accounted for 84.9% of all federal spending and federal spending comprised 43.6% of GDP.

Essentially, what happened was that huge (for the time) sums of money were borrowed -- much of it printed up by the Fed -- so that government could spend it purchasing tanks, guns, ammo, warplanes, aircraft carriers, etc. As this process proceeded, government -- one assumes -- recaptured a portion of these expenditures by taxing the profits of the companies that produced the war materials.

So the fact that corporate profits can increase even as taxes are increasing does not contradict the theory. The theory only predicts that profits would have increased even more had the taxes been lower.

I suggest you analyze the theory introspectively, anonymous. Is your motivation to produce (to work) unaffected by the size of the financial reward you’ll get in return?